23 Things We're Telling You About Capitalism XXIII
Chang's twenty third thing is that we really don't need to have lots of bright economists around in order to be able to run a decent economy. This is most certainly true provided that the economy is still run along the right basic lines: which might be the bit that we and Chang disagree about.
It's certainly true that all the time markets, nothing but markets, doesn't quite work. There are a number of imperfections that mean that we cannot just leave everything to voluntary action. We might point to natural monopolies as an example: someone, somewhere, has to stop them rooking everyone. We do like the rule of law which means we've got to have government (sorry anarchists) and the taxes to pay for it (sorry everyone). And there are more subtle problems out there: take externalities for example. By definition these are things that are not included in market prices and therefore are not considered in market transactions. We really cannot therefore conclude that markets will deal with externalities when hte whole point is that markets ignore externalities.
So we're all fine with the idea that we cannot have an entirely and wholly pure market system. Nor would we want one that is entirely capitalist: I'm extremely happy about the idea that the Army is a State run organisation. We tried private capitalism in this field and the Wars of the Roses just don't have that good a reputation. Not from the peon and churl end of the telescope at least and I know darn well that's where I would have been.
However, that doesn't mean that because we cannot be purist about these things that therefore any old intervention into the economy is just fine. Which is what Chang is partly doing. Having shown that some intervention is demonstrably desirable he then goes on to conclude that the sort of intervention he desires has been demonstrated: which the past 22 little notes might have dissuaded you of.
But I will agree that he's right: we don't need vaslty intelligent and highly educated economists running the place for us all to get gloriously rich. As Adam Smith himself said:
Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice.
You'll note there's nothing there about managing the exchange rate, regulating the bendiness of bananas nor even one word about the employment of economists.
So of what use actually is economics. If we don't need economists to run the country then what point in the entire intellectual exercise? As Ben Bernanke has observed:
Having taken a stab at sociology and political science, let me wrap up economics while I'm at it. Economics is a highly sophisticated field of thought that is superb at explaining to policymakers precisely why the choices they made in the past were wrong. About the future, not so much. However, careful economic analysis does have one important benefit, which is that it can help kill ideas that are completely logically inconsistent or wildly at variance with the data. This insight covers at least 90 percent of proposed economic policies.
If I am to be fair about economics there's very little in the corpus of knowledge that makes up the field that is really about making the world a better place. Plenty of attempts at such of course, and many more from people who wouldn't know an econ if it came and micced them. What there is a great deal of is warnings about don't do this because you'll make the world worse. As PJ O'Rourke put it about the Soviet Union, shooting all the smart people and then killing off anyone trying to get rich does not great societal wealth make. We've got lots and lots of knowledge about things like that that we shouldn't be doing. There are some areas where things have to be done: those natural monopolies, externalities and so on. But they're few and far between when you think of the vast possibilities of human behaviour.
The real point of economics is to struggle manfully with those very few things which must be done, shoot down in flames at least 90% of the things that are suggested we should do and then leave the rest of it, the vast majority of life, to people to do as they wish as long as they're not harming others or their right to do the same. You know, the liberal idea of free people interacting voluntarily in a free market. Capitalism's just an offshoot of the rights to private property: and one of the lessons of the experiment that was the 20th century is that we do have the data about what happens when you try to do that.
So, capitalism and free markets for all it is then. Which, given that the last 30 years, as the two have spread through globalisation, has seen the largest reduction in absolute poverty in the history of our entire species, is very probably a damn good idea. After all, even if we don't need many economists or much economics to do it, the poor getting rich is what we all want, isn't it?
23 Things We're Telling You About Capitalism XXII
Our twenty second thing is the rather alarming suggestion that finance must be made deliberately less efficient. This is a very odd indeed thing for an economist to say for our first assumption, right at the very start of the subject, is that the needs and desires of human beings are larger than the ability to assuage them. Thus increased efficiency is always desirable as it means we can assuage more desires with our limited stock of resources. Indeed, we usually go on to say that something that is in infinite, as compared to demand or desire for it, supply is not actually an economic good. So deliberately calling for less efficiency, no, not as a side effect of something else but as an aim in itself, is almost a form of anti-economics.
The claim is that finance now moves more swiftly than the "real" economy. Thus we must slow it down otherwise finance will be, erm, moving too quickly for said real economy. There's no evidence proffered for this assertion: it is simply asserted. People can buy and sell shares quickly which means that the money to build factories, something that takes some time, isn't around seems to be one lunge at a back up. Which is a very strange argument indeed as we don't seem to have any shortage of factories. Nor of investment to build them if someone comes up with a good idea. Indeed, the world seems to be awash with VC funds, with FDI, with bond funds looking for a good home for their cash. Far from finance not funding that "real" economy it's amazingly easy to get cash to follow an idea through, easier than it has ever been I would wager. And there are plenty of people, Nobel Laureates among them, who insist that the recent troubles were all about a global savings glut.
There is one shortage, this is true. Banks (especially UK ones) being unwilling to lend into companies. But this complaint is really just a disguised misunderstanding. Banks simply aren't the appropriate place to get risk capital from: public markets or private investors are. And as I say, there's no shortage of that sort of funding at all. SMEs aren't all that fond of it, true, because gaining such finance means giving up equity. Which is as it should be of course: you want risk capital you've got to share the upside as well as the downside.
Other than that there simply isn't a shortage of capital for companies: so the basic complaint seems invalid. Maybe finance is running faster than the real economy. Finance has certainly screwed up memorably in recent years as well. But if that real economy does still get funded, as well as all the froth that's being complained about, then we can't use the real economy not being funded as an excuse to do anything. And it should be noted too that a lot of the froth is actually the sharing of risk from those real world investments. The wheat futures market spreads the risks the farmer and the baker are taking: meaning that more funding can be offered as risk has indeed been spread. This continues out to even the most exotic markets. Sterling interest rate futures, as one example, mean that both borrowers and lenders can shift the risks of interest rate changes to speculators. Thus meaning that for the same amount of risk carried by lenders and borrowers there can be more lending done. The froth doesn't detract from that real economy funding: it adds to the ability to increase the volume of it in reality.
And I must say that I was most amused by one piece of evidence called in by Chang. He notes that the profitability of the finance sector has risen in recent decades. He uses this as the basis of a claim that obviously it should be pruned back. But profit, excess profit, as Adam Smith pointed out in not quite these words, is proof that you are adding value. So if profitability of finance has risen then that must mean that finance is adding more value. And the idea that we want to stop people doing that is again almost anti-economics.
I suspect that the real basis of Chang's complaints about finance is that his attitude towards it is akin to a Victoiran dowager's about "trade". We know that it goes on, is even necessary, but we most certainly wouldn't want anyone we know to be associated with it.
Chart of the week: Eurozone unemployment keeps rising
Summary: Euro area unemployment rose to an all-time high of 12.2% in April
What the chart shows: The chart shows unemployment as a percentage of the labour force in the 17 countries sharing the single currency
Why is the chart important: Unemployment is a lagging, not a leading indicator. This means that it is an effect, not a cause of economic developments. However, it is an important indicator that highlights the amount of spare capacity – slack – in an economy. Rising unemployment is also an indicator of below-par growth. The concern in the euro area is that the continued absence of growth and hence continued rising unemployment will exacerbate social tensions. The euro, allegedly an instrument for greater unity in Europe, is instead forcing the continent apart.
Happy 290th Birthday Adam Smith!
Had Adam Smith somehow survived until today, he would be 290 years old, having been born on 5th June 1723. The economist, now adorning the £20 note and credited with founding the modern discipline of economics (or political economy as it was known earlier) was originally renowned as a moral philosopher for his widely respected Theory of Moral Sentiments.
Go here to see Tyler Cowen and Alex Tabarrok (economists at George Mason University) explain why he was the greatest economist of all time.
Go here for Adam Smith Institute Director Dr. Eamonn Butler's The Condensed Wealth of Nations (and the Incredibly Condensed Theory of Moral Sentiments).
23 Things We're Telling You About Capitalism XXI
The 21 st thing is that a larger government actually makes economies more flexible: thus we should have larger governments in order to increase the necessary flexibility of the economy. And if the first part were true then the second part might indeed follow: only it isn't, at least not in the sense that Chang means it.
As part of his argument there's one thing that Chang does which is really very naughty indeed. He compares the growth rates of various European countries to that of the US. And he divides the growth rates into two periods: early 1950s to late 70s, late 70s to now (or what was now when he wrote a couple of years ago). He's right that the European economies, with their larger state sectors, grew more quickly than the US did in the earlier period. Hence the claim that larger government can mean more economic growth. Except, well, there's just one thing missing from this calculation: the Wermacht. As the perceptive will have noticed the German Army did have something of a European tour in the years immediately preceeding the early 50s. And the destruction of getting them to go home again was considerable: something which did not happen to the US at the time.
Just as we expect a developing country to have a higher growth rate than a developed one, given that copying is easier than being at the technological cutting edge, so we also expect an economy recovering from a total war being fought on its territory to grow faster than one which is not. So while the growth rates are true we cannot use them as proof that larger governments will create more economic growth.
The real problem with Chang's position though is that he confuses two entirely different things. He talks about employment inflexibility: the way in which it's difficult to get fired and thus the workers all feel secure. He also talks about the existence of a decent welfare state: unemployment pay, health care, retraining opportunities and so on. The problem is that he sees these as being equal: both increase the security felt by the workers and thus increase their flexibility. Which is untrue: they work in very different ways indeed.
It is true that a decent welfare state does lead to greater flexibility in the economy. The workers (and everyone else in fact) will be less stuck in their ways if they know that a change in the economy does not mean destitution. But job security works entirely the other way around: those who are too secure in their jobs won't accept any change at all. Thus reducing the necessary flexibility of the economy.
The reason that this becomes important is because Chang points to the Nordics as evidence of his assertion that you can still have decent economic growth with a large government sector: indeed that it increases growth to have a large such sector. But the very success of the Nordics argues against all of the other strictures about free markets and capitalism that he wants us to understand and adopt. For it is true that they do have large and generous welfare benefits: the unemployment pay, the retraining and so on. They also have decent economic growth. But what they don't have is the sort of regulation, planning and government intervention into the economy that Chang proposes. Look behind the tax numbers (necessary to pay for those benefits) in the economic freedom index and look instead at everything else. They have less regulation of markets than we do, greater economic freedom than even the US, less intervention into capitalism than just about anyone other than Hong Kong. Which is what makes the places work of course: as Scott Sumner is fond of pointing out, Denmark might well be the most classically liberal economy on the planet underneath that welfare state.
All of which I admit I find rather amusing. It is true that the Nordics are nice places to live, despite those crippling tax rates (almost all of which are tumbling down). It is indeed true that they've had very decent economic growth over the years and decades. It's entirely true that they have a lavish social insurance system. But those economies work precisely because they ignore, do absolutely the opposite of, everything else that Chang proposes a government should do to an economy. They're more free market and capitalist than even the US: which is why they work. Indeed, it's probably true to say that the only way in which you can have a social safety net like they have is if you allow capitalism and markets to let rip: how else can you possibly afford to pay for it all?
Why should benefits be universal?
Ed Balls, the economic spokesman for the UK's opposition Labour party, has suggested that wealthy pensioners should be stripped of their winter fuel allowance. At present, over-60s eligible for the state pension receive £200 a year, and those over 80 receive £300, to hep keep them warm. The policy was introduced some years ago after media stories of pensioners suffering from hypothermia because they could not afford to turn on their heating. Even those in care homes get fuel payments of £100-£150.
Government figures show that withdrawing these winter fuel payments from pensioners who earn enough to pay the higher income tax rates would save £105m. Not a huge dent on an annual government budget deficit of £120bn a year, but every little helps.
The remarkable thing, though, is that a Labour politician should attack the principle of universal benefits at all. (He must, as Westminster-watchers believe, definitely be on the way out.) Giving state benefits to everyone might waste money on people who don't need it—£200 is not a lot to a top-rate income tax payer. But the argument for making state benefits universal is not just that it is administratively easier to do than trying to target the money. The argument is that universality gives the middle classes a stake in preserving the benefit system, as they gain from it too.
I have always thought it a pretty odious argument: that we should waste taxpayers' money on people who do not need it in order to buy their political support for more generous state benefits. And the result of including the middle classes is that they do very nicely out of the deal. Being articulate, politically astute and well represented in Parliament, the welfare state has elided into a system designed for them, rather than the poor. Not just cash benefits, but free healthcare, free education and all the rest – people who could well afford to pay are the biggest gainers.
We need to scrap this entire system of middle-class state patronage and replace it with a negative income tax, so that we can see clearly how much we are spending on welfare support and so that government—and political—activity is clearly focussed on those who genuinely need it.
23 Things We're Telling You About Capitalism XX
For our twentieth outing we're told that equality of opportunity isn't enough: we must also have a deliberate and planned levelling of outcome in order to produce a truly just society. Chang manages to reach this position by confusing inequality with insufficiency: something not unknown over there to the left of us. But I'm afraid that this is an incorrect conclusion for the two things really are very different indeed.
Fortunately Chang is agreeable to the idea that entirely equal rewards for very different efforts doesn't actually work. There has to be, unlike Maoist China, some connection between the work put in and the relative rewards taken out. Which is true: but that's not quite right even there. For the truth is that we shouldn't really be caring at all about the efforts that is being put in. We are not Puritans, we do not think that work for its own sake is good. Indeed, I myself am very much an Anti-Puritan in this sense. I care not a tittle nor a jot how much work someone puts in to make their money: they're going to get some of mine according to the value that they produce for me. And that's also how it should be on the macro scale, in the entire economy. If, just as an example, Eddie Izzard finds it takes mere moments to think up a joke which has millions laughing for hours then good luck to him. It's not the effort put in that matters, it's the value he's created that does. Ditto with, say, the miner digging up tantalum to make our mobile phones. None of us gives a hoot whether it takes him 30 seconds or ten hours: the value is in the capacitors in the phones and that's what we're paying for.
That rewards should be commensurate with effort is a corollary of the fallacious labour theory of value. Rather than Adam Smith's much more correct theory of the value in consumption. With this correction we can move on. Now that we accept that it is the value produced for consumption by others which should determine income and reward, not the effort put into that production.
Where Chang does go wrong is in his insistence that true equality of opportunity isn't enough. He uses the example of a poor black child in South Africa: the schools are terrible, the teachers barely literate, in what sense can we say that he has equality of opportunity with his witer and richer fellow countrymen? He doesn't, of course. equality of opportunity would mean at least comparably good schools. Chang then compares this to the UK say, where a poor child won't have perhaps the same self-confidence as his richer contemporaries. Nor the same luxuries in his home life. All of which might well be true. Then comes the sleight of hand: this inequality of opportunity requires that parental incomes thus be equalised in some manner. Which is, I have to admit, an interesting use of the "it's all for the children" argument.
But it's an incorrect argument: equality of opportunity does not require equal incomes: it requires sufficient incomes. Sufficient to be clothed, fed, housed, warm and so on: sure, it needs all of those. But making sure that everyone has a sufficient income for their children to be provided with these necessary things is very different from insisting that incomes must be more equal. It might be a valid argument for some redistribution even, to ensure those sufficient incomes, but not for more equality of incomes as a specific goal. Imagine, just as a made up number, that it requires £5,000 a year to provide a child with a sufficiency of these things. If all children have that amount available for their care then we do have equality of opportunity in this education and life success sense: that other children have £40,000 a year lavished upon them does increase inequality but does not cause a reduction in opportunity.
That slide from having to reduce inequality to provide equality of opportunity just doesn't work I'm afraid. And given that we want reward to be tied to the value produced for others to consume, the evident and obvious truth that some do, with varying levels of effort, produce very much more value than others means that we're just entirely happy with inequality of reward: as long as we do have that equality of opportunity.
Cash, questions, lobbyists—and perverse regulation
UK Member of Parliament Patrick Mercer has resigned under accusations that he took cash (from journalists pretending to be lobbyists) to ask questions in the House of Commons. It has renewed calls for lobbyists to be registered and regulated in order that we know who our MPs are talking to.
Regulations invariably have the opposite effect of those intended. Such a move would damage independent debate. After all, policy think-tanks also talk to MPs. They may be utterly independent, getting their funding from public subscriptions rather than from companies. But if any organisation that talks to an MP has to register itself as a 'lobbyist', what is the result.
We have seen the result in the United States. Think-tanks carry on as before, but they have to set up a separate 'lobbyist' body comprising any of their personnel who have frequent discussions with folk on Capitol Hill. The effect is to politicise think-tanks and put a wall between their independent policy experts and the politicians. An issue comes up, a think-tank expert has important things to say, but cannot say them directly to the policymakers.
What is the best solution? Doctor, heal thyself. MPs should certainly declare their interests and whom they take favours from. But if MPs could be subjected to recall motions by their constituents, they would be a lot more careful about taking favours from business – and perhaps more careful to listen to independent policy advice.
Ultimately, though, if individuals ran their own lives and Parliament had a lot less power, it wouldn't be worth lobbyists (and journalists, let's remember) trying to bribe them.
A question for market monetarists
Market monetarism, as propagated most prominently by Scott Sumner's (excellent) blog The Money Illusion, argues that recessions come about due to a collapse in demand. This is a problem because prices cannot adjust downwards quickly. Instead of a costly adjustment period we can simply boost demand by announcing a target and credibly committing to do the necessary quantitative easing (buying gilts to inject money in the system) to achieve that target.
This makes a lot of sense. Markets are finding it hard to clear; we boost AD to put the situation back where it was; now markets find it easier to clear. But lots of the best market monetarists, including Scott, Lars Christensen and many others, argue that right now what we need is more stimulus, because the economy is still in a bad shape, and it is still due to a shortfall of demand.
Last Tuesday Professor George Selgin delivered an extremely interesting lecture at the Adam Smith Institute making the case for productivity driven deflation. He said he agreed with the market monetarists that there is "bad deflation"—the sort that means nominal rigidities stop markets from clearing—but there is also "good deflation", from productivity improvements—and this is not associated with unemployment, stagnant or falling GDP, or any other cyclical issue.
After the talk I quizzed him on whether he agreed with the market monetarists that even though the ideal is a rule-based system, as opposed to the current discretionary way policy is set, right now the best discretionary policy is more easing, because that's probably what the ideal rule would require.
Prof. Selgin disagreed, arguing that we didn't need easier policy, and if you look at the graph above there's at least apparent reason to agree with him. Nominal GDP—aggregate demand—is not only well above its pre-recession peak in the US, but is growing at an apparently steady rate, roughly in line with its long-term trend. If the high unemployment in the US is down to insufficient demand combined with nominal rigidities then why hasn't a long period of higher-than-pre-crisis demand brought unemployment back down.
According to Selgin, policy uncertainty and pro-cyclical strictness in enforcing regulations (particularly risk-weighted lending rules that rate Greek bonds as zero but loans to small business at 100%) are holding firms back from investing their cash piles in capital and it is this that is stopping the robust recovery. He made the point very convincingly and despite trying hard to argue against it I couldn't find a good reason to disagree, except that I hadn't seen a good measure of the importance of these two factors so it was hard for me to compute how big their influence really was.
But many market monetarists—along with New Keynesians and most others—seem very sure that insufficient demand is the overriding factor holding back recovery, in the US as much as the EU, UK and Japan (where NGDP growth is further below trend). So my very genuine question is: upon what arguments and/or evidence do they rest this belief?
23 Things We're Telling You About Capitalism XIX
Our nineteenth thing is that of course planning's lovely: so much so that the collapse of communism isn't to be taken all that seriously., Yes, OK, so the central planning of the entire economy isn't all that good an idea (although Chang, almost ludicrously, believes that it did work in the early days. Someone should point out to him that the 5 year plans reduced economic growth from the NEP days: to say nothing about losing 8 million Ukrainian peasants by happenstance along the way.) but still there's a place for the very clever people in government to direct what everyone else thinks about making, buying and selling.
And even if that isn't true firms plan their activities, we've got lots of firms, so we must have lots of planning: and indeed we do have lots of planning.
The problem with this is that he's mixing and matching in a way that isn't really viable. Firms do indeed plan: but their plans are then subject to examination through competition with the plans of all the other firms. You know, that marketplace thing. Planning is thus preparatory to the test of whether the planning has worked. With government planning we don't then get that test: for governments don't then subject, or at least limit as much as they can, the exposure of their plans to said market. You can see this quite clearly in the current arguments about renewables and fracking for shale gas. The DECC has its plan, we'll all shiver in the gloom of solar powered (in England!) lights so therefore no one must be allowed to drill for shale which would upset that plan. Yes, I know they've said that it will be allowed to go ahead: but have you looked at the limits they've put on earthquakes? 0.5 on the Richter Scale was the last I saw: that's about the shock of the cat jumping off the bookcase next door*. A deliberate attempt to stifle an innovation that would ruin the government's plans. This is something that private sector companies don't get to do: which is why the results from private sector planning work out so much better. Someone else can indeed derail them, to the consumers' benefit, by having a different and better plan.
If you like, the market is where plans compete to see which is the best one. Government planning doesn't enter that competition so we never do find out quite how bad those government plans are. We just end up not quite as rich as we thought we were going to be or should be.
Chang also talks about how governments plan a lot of the R&D these days: or at least pay for it and thus presumably have some sort of plan about what they're going to spend it on. He also notes that the Soviets were pretty good at invention of spiffy things but this didn't seem to feed though into making said consumers any better off. He should read his William Baumol to see the connection between these points.
Baumol defines invention as the, well, invention of new and spiffy things. He makes the point that the Soviets did do satellites first. Indeed, either sort of system, planned or market, seems to be about the same at invention as the other. However, innovation is the getting of interesting things stemming from those inventions into the hands of consumers in a shape and form they desire. Either to do things with or to develop further to do other things with. And there the planned system is appalling and only market economies have ever really proven to be any good at all at it. The Soviets could make tanks alright but hot water tanks were beyond them (quite literally, the Soviet housing system didn't have them).
Which is really very much the same point as the one above. Markets provide the test to see what an invention might be used for, who is going to innovate with it. Further, given that we're talking also about capitalism here, that part of the system provides the incentive to risk the money to find out about one or other innovation. Which is why innovation is indeed driven forward on capitalist and market based societies and not in planned ones. OK, so governments pay for a lot of the R&D. So what? That's not the important part of the system: innovation is, not invention.
Which brings me back to hot water tanks. The Soviet system operated on district hot water heating plants. Hot water piped into the radiators and bathrooms of the whole urban area. From a planning point of view is looked quite efficient: but as it turned out it's not what the consumer actually wanted. As soon as the old system fell one of the most popular additions to a Russian apartment was an individual hot water system: the type of tank that the Soviets, the planners, didn't even know was wanted rather than the ones they knew how to build but which the market sniffed out almost immediately it was allowed to.
And that, in the end, is why planning is inferior to markets. Because planning will provide what the planners think the people want, or should want, or even what the planners think they should have. Markets allow the consumer to do the demanding of what they do want.
*Hyperbole alert. Update: I have now been told that it's actually 3,000 cats jumping off a 2 metre bookcase. No, really, it is, assuming perfectly inelastic cats. And it's also happening half a mile away.....